Fitness product company Peloton Interactive (PTON 2.66%) tends to elicit strong opinions among investors who either celebrate it as an innovative replacement for gym memberships or condemn it as another health fad like the Bowflex and Tae Bo from years past.
For the naysayers, thinking of Peloton as the company that offers the "bike with an iPad strapped to it" is just not telling the whole story. Here is what the market might be missing.
Peloton's hardware is the near-term story
At the same time, don't make the mistake of entirely dismissing the importance of Peloton's hardware. The company must continue to move bikes, treadmills, and whatever else it comes out with in the future. Hardware (branded apparel is lumped into this) continues to drive the business, making up 81% of fiscal 2021 third-quarter revenue of $1.26 billion.
Peloton is expected to hit $4.0 billion in revenue in fiscal 2021 (which ends June 30), a 119% increase from the prior year. The company just went live in Australia in July, and the relaunch of its treadmill system is pending after safety issues triggered a recall.
Image Source: Getty Images.
So if Peloton's story goes beyond hardware, why is it still important? The hardware is an entry point for customers into Peloton's ecosystem. It's actually quite similar to what Apple was doing earlier in the decade when all investors cared about was iPhone sales, despite the phone being a means of locking customers into all of the company's emerging services.
But its content platform is key to long-term success
Peloton's subscription-based content is what will determine how successful the company is over time. Going back to the third-quarter numbers, Peloton's subscription memberships generated $239 million, or just 19% of revenue, but they contributed 35% of gross profit.
In the year-ago quarter, subscriptions generated gross profit of $57 million, or 23% of total profits for the quarter. So what changed? In that one-year period, connected fitness subscribers increased 135%, and digital subscriptions (the app without features that require the Bike or Tread) grew 404%. The membership base now totals 5.4 million.
Peloton invests in developing workout content. As the membership base grows, the profitability of its membership platform should increase so long as revenue growth outpaces the company's content spending.
And good content is key to keeping customers on board. Peloton's churn for the fiscal third quarter -- the percentage of people who leave the service -- was just 0.31%, a six-year low. For comparison, quarterly churn for premium streaming companies such as Netflix, Disney, and Apple can range from about 2% to 15%.
Continuing to grow the content platform
Maintaining the quality of Peloton's content and growing its footprint is the long-term story that investors need to follow. Founder and CEO Jeff Foley is continuing to stay aggressive in this area.
Peloton recently announced a partnership with UnitedHealth Group, the largest health insurer in the United States. The deal will give all 45 million UnitedHealth members 12 months of free access to Peloton's digital programs or a four-month waiver toward connected fitness. It's a great opportunity for Peloton to gain exposure to a vast pool of potential customers. Even a small number of those who convert to paying members (or buy a Bike/Tread) will help Peloton continue to grow.
The company is trying to use content to gamify exercise, announcing that it's developing a game called Lanebreak, where members will match cues from the game to dictate their workout. Peloton made it clear in its announcement that this effort is currently in testing and will launch this winter. It's a new direction for the company -- success could mean a whole new category of content on the platform.
Is Peloton a buy?
The stock currently trades at a price-to-sales ratio of 8.8 based on its expected fiscal 2021 revenue of $4.0 billion, after trading at a multiple of more than 12 earlier in the year. Even though Peloton is set to grow revenue 119% in fiscal 2021, the high concentration in hardware sales has earned the stock a lower valuation than other, more software-focused growth stocks.
Investors shouldn't lose sight of hardware sales, but the long-term story is the growth of Peloton's content platform. Successfully turning its content into the high-margin ecosystem that keeps members engaged could make the difference in Peloton being a good investment or a great one.
